Sunday, June 12, 2005

The Last, Best Hope For Prosperity

I bought Time Magazine today for the first time since…probably since 9/11, when I bought every newspaper and magazine available with a cover story on the World Trade Center attacks. The relevance of a weekly “news magazine” these days is, after all, right up there with “Book-of-the-Month” clubs and the Sears Catalogue.

Nevertheless, I bought this new issue of Time Magazine because the front cover is titled “Home Sweet Home” (stamped in large letters, the “S” converted into a Dollar sign) with an illustration showing a man covetously hugging a house. The sub-title reads: “Why we’re going gaga over real estate.”

I bought it, quite simply, because this Time Magazine is as good a “cover story” kind of market-mania, surely-we-are-approaching-a-top indicator as I have ever seen.

Now, careful readers who’ve been asking about the promised follow-up to last Thursday’s piece on internet-jewelry retailer Blue Nile will have to excuse me. As fun as it is to chronicle the bizarre public musings of Overstock.com CEO Patrick Byrne and his company’s failure at pretty much every new venture he touts to Wall Street—the latest being a Blue Nile knockoff—the current issue of Time is both fecund and worth a good look.

So we will get back to Doctor Byrne and his false-rumor-spreading appearance at the Bear Stearns conference, eventually.

It’s just that, when a Time Magazine comes along declaring “Record home prices are inflaming passions—and pocketbooks—as never before,” well, as Willy Loman’s wife said, attention must be paid.

After all, this is still a magazine with a circulation of something like four million, and its sole function in the world is to sell as many copies as possible before they get recycled into cat litter or something else.

Obviously, the editors of Time believe that a feel-good article about the joys of home-ownership—actually, more precisely, about the ability of average people to strike it rich by buying, flipping, or just putting down deposits on as-yet-to-be-built condos—will sell a lot of copies. Making it, of course, red meat to anyone who’s seen more than one cycle on Wall Street. So let's take a look.Opening the “Home Sweet Home” cover of this latest Time Magazine, one finds an article titled “America’s House Party” which begins with the Siren Song of all bubbles, whether the South Sea Bubble of the 1700’s or the Internet Bubble of the late 1990’s or the Tulip Bubble of the 1600’s or the Oil & Gas Bubble of 1980: the guy who sees his friends doing it:

“I saw so many friends and colleagues getting rich,” John Williams, a disc jockey from Long Beach, tells the magazine, “I wanted to get rich too.” So Williams is buying houses, fixing them up and, according to the article, “flipping them for a quick profit.”

Furthermore, unlike most of the Housing Bubble stories recently appearing in various newspapers and magazines, this article is a straightforward encomium to the financial rewards of buying, selling, trading or owning a house:

The stock market may be dragging, but home prices are soaring, fueling a national obsession with real estate.

Your house is now your piggy bank.

House gawking is a hobby; remodeling, both entertainment and an investment.

Folks brag about having bought their home in the ‘90s the way they used to brag about having bought Microsoft in the ‘80s.

Real estate isn’t so much about nesting today as it is about nest feathering.

And—I’m not making this up—that’s just in the first two paragraphs.

The article goes on, with the usual Time Magazine-ish snappy quotes from newly-minted tycoons; weirdly all-encompassing-yet-inane statements (“It’s about the giddy tabulation of how many plasma TVs your house’s appreciation could buy and the embarrassment of feeling too poor for your neighborhood as houses around you are torn down for McMansions…”); and, of course, simplified, happy graphics.

However, as in all manias and bubbles, lurking within the happy graphics are some potentially disconcerting statistics, if you really look at the Time Magazine charts.

They show, for example, that the number of second homes purchased in America stayed within a range of 300,000 to 400,000 a year from 1989 to 2002—then suddenly doubled to over 800,000 in 2003 and broke 1 million in 2004. Home equity loans have also spiked, at the same time that rates appear to have bottomed and are moving higher. And in several non-sexy, non-condo, non-second-home-inflated states, mmortgage foreclosure rates have tripled.

But you will not read about all that in the article itself, for Time readers presumably do not want to read about anything except how much fun this house flipping thing is.

There’s a trivia “test,” although it is not designed to test the reader’s knowledge of issues that might have a bearing on whether they are familiar with ARMs and IOs and transaction costs—knowledge that might be useful as they toss their chips into the game.

Rather, it asks things like “Which of these entertainers has sold at least seven homes in the past 10 years?” (Answer: Courteney Cox, although why anybody would care about that is beyond me.)

More interesting than the graphics or the cute quotes, is a look at a single block in a Chicago neighborhood, detailing how the real estate boom has affected seven different houses:

House 1 has a middle aged owner who did a tear-down/rebuild on the house, and is reinvesting the equity in other properties, the profits from which “will put my kids through college.”

House 2 has a long-time owner “using it as a piggy bank,” via home equity loans.

House 3 is an eventual tear-down whose long-time owner hates what has happened in her neighborhood.

House 4 was sold by its previous owner after property taxes rose 1,059% in 10 years.

House 5 is being sold by its long-time owner to support her retirement.

House 6 has been flipped twice in seven years.

House 7 was inherited; the owner did a recent tear-down/rebuild.

Further on, and like the dot-com stories from the late 1990’s, the article is chock-full of real-world people throwing off the shackles of benighted thinking and plowing their worldly savings into housing.

Maybe you’re like Mike Oakley, 43, who has poured $100,000 into redecorating his Chicago house, figuring it is already worth $150,000 more than when he bought it. “Rather than invest in stocks,” Oakley says, “invest money in your home.”

You shouldn’t get the impression that you can make six figures in real estate by snapping your fingers. Just ask Max Kaiser. It once took him a whole hour.

“Buildable land here [in Las Vegas] is running out. We have only one place to go, and that’s up.”

“We might be riding that wave,” he [a General Mills operations manager considering switching to the real estate business] says. “But the wave is there. So I’m going to get on it.”

And it’s not just Young (and-never-seen-a-down-cycle) Turks grabbing for the gold who are being celebrated here; it’s the old-timers, too:

Of course, you don’t need a portfolio of condos to have made a pile. Average homeowners who bought in the ‘90s…are now, like modern-day Clampetts, sitting atop newly discovered gushers of wealth.

As I recall the “Beverly Hillbillies,” the kids were morons and Granny was a lunatic. The only smart one in the bunch was Jed Clampett, a cagey old redneck, and he had wisely sold his “newly discovered gusher of wealth” and put the money in the bank...giving Jed the right to drive poor Mr. Drysdale insane.

Of course, nobody here in Time-land is doing anything of the sort, except a few renters, as the article notes in a brief piece called “The (Surprising) Case For Renting” appended to the end of the eight-page “America’s House Party.”

Yet buried within the “Case For Renting” is a cautionary paragraph containing the seeds of what will, I expect, mark the germination of the seed containing the eventual reversal in the Housing Bubble:

The Choes aren’t alone in finding value in the rental market. With so many people buying homes in the past few years, landlords in certain frothy markets, like San Diego, Miami, Las Vegas and Washington, have gone begging. Not a few are collecting less rent than they are paying in mortgage expense. Their bet is that in the end, rising values will make up for their losses.

They “will make up for their losses,” of course, because, as we have been told by a Las Vegas player earlier in the article, “We have only one place to go, and that’s up.”

Anybody who reads this article—and I mean anybody, whether they are the last remaining Communist still farming onions on a collective outside Vladivostok, or a jet-setting, highly-leveraged real estate mogul who pretends to be worth more than he is, like Donald Trump—will feel that internal sense of failure, jealousy and greed that they, too, are missing out on something more.

Gushers of wealth…nest feathering…piggy banks…getting on the wave…only one place to go, and that’s up....

It’s all here in Time Magazine, available on your newsstand today: The Case for Owning Real Estate in America.

You have to excuse homeowners for getting a little giddy. When they look at the rest of the economy, they see little else to be excited about. Employment has picked up, but wages haven’t [not true: just last week it was reported that wages rose 6.3% last quarter, the largest first-quarter increase in years]. Inflation has risen from the grave. The stock market is crawling to get back to where it was five years ago [also not true: most stocks are higher than they were five years ago]. Savings accounts throw off barely enough interest to feed a parking meter [also not true: short rates have tripled in a year].

So people see their homes as their last, best hope for prosperity—as not just houses but also lifeboats.

Compelling, is it not?

Very nearly as compelling as a previous Time cover story on a similarly widespread investment mania that also, according to many, looked like the “last, best hope for prosperity.”

You may recall that Time Magazine cover story. It was published in the fall of 1999—September 27th, to be precise. It was titled:

“Get Rich.Com: Secrets of the New Silicon Valley.”

Jeff MatthewsI Am Not Making This Up

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.

33 comments:

Agreed, RE is subject to much speculation and overvaluation. What if someone was selling their home and wanted to hedge themselves for the next 2-3 months while their home was in escrow? Would you recommend shorting REITS, Homebuilders, bond funds or something else?

And i am also wondering if the home sales data is all wrong or "fixed" ...I have a few pals in the business and they think things have been declining in Bergen and Passaic counties NJ for some time now...Beats me but i smell a rat.

Don't quite get the drift of the first couple of comments; must be something to do with the bubbles I suppose, anyway….

Having only just received and read my copy of Fortune June 6, No. 9, front cover: "Real Estate Gold RushInside the hot-money world of housing speculators, condo flippers, and get-rich-quick schemers. (Is it too late to get in?) - (International Edition), one wonders if one magazine follows the other, even if they are owned by the same people.

The Fortune conclusion is interesting and possibly more responsible, with the final paragrah saying things like “But even some diehard speculators…..are starting to get nervous” and “’It was like a gold rush….everyone was flipping….’”. What is more fascinating is the Wall Street Banker who seems to be only now moving into the real estate market. Either’s he’s been asleep for the past few years, just recently got a fat bonus or more likely, can’t resist that market anymore and has to get in. Another sign of a top if there ever was one.

"Foresight": I personally wouldn't make plans to hedge a home sale for a two or three month period on the assumption that the housing market might suddenly seize up. Houses are not like stocks, where valuations change minute by minute or day by day. Also, shorting REITS or the homebuilders against your own home sale is not a real hedge.

(My personal experience in buying and selling homes is that the housing market always moves slower than us Wall Street types have come to expect from watching stocks all day.)

"Sandman" is dead on noting the Fortune article, and after I posted this piece I noticed Money Magazine also has a cover article on real estate: "Special Issue: Your Home," with "Why it's still your best investment."

As for "Sandman's" question about the first couple of comments that had nothing to do with this post, I have deleted them and remind readers this is not a Yahoo message board: what we value here is informed observation and information. Anyone attempting to hijack the discussion or go off-topic will be deleted.

Finally, I'll wager every person reading this blog has a personal observation or experience with the Housing Bubble, and I'd love to hear them.

First off it's Courtney LOVE, not Courteney Cox. You were suffering from a Courteney Merge, happens to the best of us.

I know some mortgage brokers, and I'm amazed that none of them were doing it before a couple years ago. I'm further amazed that there are so MANY of them and people leaving other careers to jump into it. I'm even further amazed the creativity with which they structure loans. I'm not sure most people understand how they are buying these things.

Re: the bubble, everyone seems to be focusing on the effectson real estate prices, but what about on consumer spending? A sizable chunk of recent spending has been fueled by the torrid real estate market (people taking out home equity lines, or feeling richer because they consider their house a form of savings). If that flow putters out, it's going to hurt more than the flip and rip crowd.

It's not Courtney Cox that married Kurt Cobain, it's Courtney Love. Courtney Cox, an actress on 'Friends', is married to David Arquette.

But back to real estate: down here in Charlotte the residential real estate market has been very restrained. We may be getting three percent annual appreciation, not too different from past years. Commercial real estate down here, on the other hand, is on a roll. All of a sudden 1031 exchanges became very popular, and it's hard to find a commercial building to 1031 into that makes sense. (A 1031 exchange permits you to sell a piece of real estate and reinvest the money without paying capital gains tax.)

selling my house...now in greenwich. greater fool theory. renting and whistling past the graveyard of mcmansions. people 5 or even 3 million $ homes should examine their logic. looking forward to when 'exotic' mortgages start adjusting upward and when the interest only payment is like having a nasty credit card debt with skyrocketing interest.

On a recent trip to Miami - this was a few weekends ago - the bell hop helping me with my bags at the hotel told me that Miami real estate was a great investment and that there were good places to be had "just down the road" for just $200-300k - a steal, he assured me.

Keep in mind that just meandering around my hotel I counted, not one, not two, not three but (at least) EIGHT buildings on Collins that were for rent or sale. Not single apartments, mind you - entire buildings. Didn't look that "hot" to me! This was between 10th and 20th streets on Collins - the heart of South Beach.

Comments from the 3rd hottest Real Estate market in the country (Reno, NV). I have been saying for over a year that our housing prices have gone to far too fast, yet they continue to climb. We purchased a new construction house for $370 in December of 2004, the same model now in the newer phase goes for $650! 7 months later! I notice the number of realtors here is going through the roof, every acquaintance I have who has struggled in their career is now either a real estate agent or mortgage broker. The current market is being driven by Californian's selling their overpriced homes and buying houses here for cash. People don't understand that we are leveraged to the California market, Yikes! People here don't realize that if California's market declines, ours does too. I spoke to a recruiter the other day who had 2 engineers placed for jobs here but they turned them down and took jobs in Texas because the housing wasn't affordable here. On the more fundamental side, a friend just told me rather than sell their house to buy another, they are going to rent the house because "even though they can't get the same amount of rent to cover the mortgage, the house will go up 10% a year. And that is being conservative." Look out below!

At my local (Venice Beach) farmer's market I was approached by two rather comely and surgically-enhanced young ladies, whose pitch was that they were mortgage brokers who could easily cut my payment or allow me to cash out.

The presumption of this pair was that anybody going to an expensive farmer's market in my neighborhood:1) Must be a homeowner (I'm not, sold more than a year ago and now renting)2) Must have lots of equity in their home. (OK, we are 4 blocks from the beach)3) Must be itching to get at the cash, rather than actually saving it in any form.

What was amusing to me was that the last time I saw their kind was back in 2000. Back then they were either working as "technology recruiters," or they were trying to sell you on daytrading opportunities. Their regular appearance at every possible venue in LA heralded the end.

As to heding against the real estate decline, or even speculating in either a continuing boom or a looming bust, I share this info.

Note: I do not know the outfit that is offering these "futures contracts" on housing prices. I do not know how reputable it is, and it appears to me that trading is thin. I am simply passing this on for information purposes.

i'm a homebuilder/mortgage broker in the san antonio, tx market. there is no bubble here and very little speculation. prices have been rising steadily, but at a measured pace...3%-5% a year. job growth here is excellent and there are equally as excellent prospects for continued growth.

i'm amazed when i hear of the incredible increases in other markets. the closest we have in texas to a bubble market is austin, which has finally regained some of its momentum after the dotcom collapse.

I haven't observed anything that would count as outright fraud. Mostly, what I've seen could probably be considered misrepresentation, or more properly -- failure to completely and fully inform.

Basically, I know a lot of people whose mortgage brokers, lenders and real estate agents have completely glossed over the risks of taking those more exotic ARM and IO mortgages. The inclination of everybody involved is to suggest that ongoing appreciation in the underlying investment will trump any interest rate risk associated with the particular product.

I put this in the same category as those investment houses who gave margin and options authorization to individuals who had no clue what they were getting into during the dotcom/daytrading bubble.

When it's all over, there will be myriads of class action lawsuits against lenders and mortgage brokers for failure to adequately disclose the risks of the products they pushed to unsophisticated borrowers.

Anyone know if ARM or IO loans are concentrated in the sexy markets ? What type of loans are vacation home buyers getting ? ....just imagine all those vacation homes recently bought hitting the market in the summer of 06.....

===============================Posted by Brandon V. on June 09, 2005 at 17:59:54:

Help! Any ideas, comments welcome.

My partner and I are in a mess with a brand new house in Las Vegas. Here are the details.

1. AUG 2004, we paid $445,000 for a Pulte model in the community of Aliante, North Las Vegas.2. 100% financed and still owe roughly the same.2. Payment is $3000/month.3. Currently could only sell for about $360,000.4. Finally found tenants to lease out for $1100/month in APR to reduce neg cash flow to $1900/month.

We are running out of cash quickly. We desperately need some ideas on how to get out of this house immediately.

Please, no more reprints from other web sites. These reprints simply retread unconfirmed data and contain with very little true value.

I am looking for direct knowledge from readers, and welcome all such stories, the positive and the negative.

As for mortgage brokers and possible fraud, I don't know about specific instances of fraud but I know a lawyer who has handled hundreds of closings of single and multi-family homes over many years in the New York City area, and it drives him nuts how many buyers get ripped off by mortgage brokers, who have been able to use the interest rate decline of the last decade to extract huge fees from unsuspecting buyers, who only focus on their monthly cash nut--and not on the fees coming out of the closing costs.

1. Friends of my wife and I live in DC right above the Metro in a 680 sq ft condo they bought about 4 years ago. Their neighbor recently sold the exact same model condo for $350k to a speculator and hasn't even moved - just paying about $1200 in rent to the speculator...whose mortgage is twice that. Our friends wanted to trade up (they do need more room) and I gave them my spiel why it was a bad idea. They proceeded to go home and contact an agent (I am very persuasive apparently!). They made an offer on a bigger place below the asking price and told the seller's agent that it was their final offer. The owner's actually called our friends directly yelling at them for having the "gal to make an offer below the asking price". This experience reinforced the madness that I talked to them about and they are now staying put. I will not claim victory until they sell and begin to rent, however!

2. I am in Hershey PA and rent a condo. Talked to my landlord who paid $65k 3 years ago for my place and the place next door just sold for $90k. At that price a landlord is slightly cash flow negative monthly - so not nearly as insane as other markets but still overpriced.

Finally, per GMO the national median household income as it relates median home price is now 2 above 2 standard deviations above the long term trend. Many of the hot markets are well above that level, and would have to decline by 25% over 5 years, assuming normal income growth, to revert to the long term trend.

This type of metric places areas like Hershey PA in a position where the market will likely be flat for a while - assuming income growth is normal. Of course, flat is bad enough considering our economy's need for the housing ponzi scheme/ATM to support spending.

I work for a money management firm in southern California and such a large number of our clients are inquiring about residential real estate - another sure sign of overheating - that we set out to survey the market and provide our thoughts. The findings, which describe how we got to where we are and the beginning traces of erosion of this mirage of endless prosperity, was picked up as guest commentary at the following site for anyone who is interested. It's the antidote to Time Magazine's twaddle.

Had 2 choices when I got out of college, get a job trading options at the CBOE or sell homes for a family friend developing gated communities in Vegas. Ended up as a trader on the CBOE floor during the exciting and profitable years of 99-02.... still wonder if selling homes in Vegas would have been the more profitable move.

I've lived in TX almost all my life, not a notoriously hot housing market. Homes/Townhomes/Condos being built all over Houston. I have lived in mine for 2 yrs. and comps are now selling for 20-30% more, that doesn't sound like much to you coastal people but it's a ton for TX, no one seems to remember the 80s when housing prices fell 50% here. Austin is the really hot market, all the California buyers there think they're getting homes for half price, but they're paying all time high prices for Austin.

Its funny, we are at the stage now where we are getting conflicting data points...just in this thread...i help a woman in her late 30s and she was told she had to move..she is renting in SF CA. I manage about $75k, most of which is in her IRA. She asked me a few months ago if she should take ALL this money and buy a condo in SF. I said no and she asked why. I said it wasn't a good time. So far the money is still intact but she could very well take it and succumb to a very serious pressure to act.

I just spent the last week pricing rentals in the Pacific NW. Home prices are going up (due to California echo-bubble effect), and all the residents want you to know that. I took my 3 kids to Seattle for the day to do some tourist things, and every conversation I overheard on the ferry, at the deli, or at the beach were concerning real estate. No kidding! It is as if nothing else is happening. It just reminds me of when I lived in Hawaii in the late 90s - People would go to bars to watch CNBC rather than enjoy Hawaii.

Prices are going up, yet rental rates are declining. I looked at a home in a Navy town where incomes are essentially capped by the Civil Service and military pay rates (no other industry aside from home speculation). The home is owned by a submarine officer and his wife. It's their "baby home," where they expect to return one day. There are all kinds of rules: no shoes in the house (hardwood floors), no painting of walls (designer colors), no hanging of pictures, and every conceivable disclaimer putting all the risk of the house deterioration on the tenant. It is as if they expect me to write a check every month as a testament to their brilliance in purchasing this home, and never set foot inside their wooded temple. I'm probably going to pass on this one.

We looked at more homes. Agents are starting to let loose that the owners are willing to negotiate the rock-bottom rents. I started asking agents what the problem is (I already knew, but I wanted to hear them confirm it).

First problem: Californians are buying sight-unseen and renting them out - causing a glut of rentals and a dearth of available homes for purchase.

Second problem: Military are buying rather than renting, as mid-grade enlisted are buying all the cheap houses and officers/CPOs are buying the higher end stuff.

Both of these trends are unsustainable.

I was once a USN officer, and the debt advisor for my squadron, and I can assure you that if mid-grade enlisted are buying homes, it will end in disaster.

Meanwhile, in flyover country...

Home prices in Dallas are flat, and affordable. If my town happened to be teleported to the Puget Sound region, and wages did not adjust to the new region, it would have the lowest crime rate in the entire state of Washington, and have the second highest median income (behind Bill Gates' Medina). Median home price in Highland Village, Texas: $210K (fully pimped out, and 2x as large as the median home in any decent neighborhood I visited in Washington). Homes stay on market for 90 days, and you are just happy to have a crappy offer.

You would not live in a $210K house in just about any neighborhood which could be commutable to Seattle, unless you were manufacturing meth.

It is going to end in tears. Rents are falling, prices are rising, and more idiots jump in with both feet.